史賽克 (SYK) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Stryker Corporation third quarter operating results conference call. [operator instructions]

As a reminder, this conference is being recorded Thursday, October 16th, 2003. Certain statements made in today's presentation may constitute forward-looking statements. They are based upon management's current expectations and are subject to various risks and uncertainties that could cause the company's actual results to differ materially from those expressed or implied in such statements. In addition, the factors that may be discussed in this presentation, such factors include but are not limited to regulatory actions including cost containment measures that could adversely affect the price of or demand for the company's products, changes in reimbursement levels from third party payers, a significant increase in product liability claims, changes in economic conditions that adversely affect the level of demand for the company's products.

Changes in foreign exchange markets, changes in financial markets, and changes in competitive environment. Additional information concerning these factors is contained in the company's filings with the Securities and Exchange Commission including the company's annual report on form 10-K and quarterly reports on form 10-Q.

Today's presentation will also include a discussion of adjusted net earnings excluding the impact of a restructuring charge and acquisition-related credit for the three months and nine months ended September 30th. Further discussion of these non-GAAP financial measures including a GAAP reconciliation appears in the company's form 8-K filed today with the Securities and Exchange Commission. Which may be accessed from the for investors page on the company's Web site at www.strikercorp.com. I would now like to turn the conference over to John Brown, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you, Kellys. And welcome, everybody, to striker's third quarter earnings report for 2003. With me today are Steve MacMillan, President and Chief Operating Officer and Dean Bergy, Vice President and Chief Financial Officer, Secretary

We are pleased to report that Stryker had an excellent third quarter and first nine months. For the quarter, net sales were $85 million, an increase of 19% over the prior year. Excluding the impact of foreign currency sales were 16% higher than last year, net earnings increased 49% to $108 million and diluted net earnings per share increased 47% to 53 cents. Excluding restructuring and acquisition-related items for third quarter of 2002, net earnings increased 28% and diluted net earnings per share increased 29%.

For the first nine months, net sales were $2,624,000,000, an increase of 20% over the prior year. Excluding the impact of foreign currency, sales were 16% higher than last year. Net earnings increased 33% to $319 million, and diluted net earnings per share increased 33% to $1.57. Excluding the prior-year restructuring and acquisition-related items, net earnings for the first nine months increased 27% and diluted net earnings per share increased 28%. We generated $437 million in cash from operations in the first nine months, allowing us to reduce debt plus the accounts receivable securitization by $264 million to $368 million.

Domestic sales were $584 million for the third quarter, and $1,697,000,000 for the first nine months, representing increases of 18% over the prior year in both periods. U.S. divisions, we think are well positioned for a great year. Howmedica Osteonics was up 21% in the quarter and 22% for the first nine months with extremely strong growth and reconstructive implants, spine and in trauma. Instrument sales increased 20% in the quarter and 17% for the first nine months with solid growth in powered instruments and strong growth in Neptune and operating room waste management systems, Steri-Shield, pain management and percutaneous cement delivery. Endoscopy sales increased 22% in the quarter and 20% in the first nine months with strong growth in video and arthroscopy and solid growth in the laparoscopy or general surgery area.

Medical was up 9% in the quarter and 14% in the first nine months with excellent growth in the EMS line and solid growth in hospital beds and stretchers. Like ger sales were up 1% in the quarter but have declined 3% for the first nine months. Physiotherapy continues its recovery, was up 13% in the quarter, and 10% for the first nine months. Primarily on the strength of this startups and acquisitions.

International sales were you up $302 million dollars for the third quarter and $927 million for the first nine months, representing increases of 20% and 24% over the prior year. Foreign currency comparisons added $23 million to the top line in the third quarter and $99 million for the first nine months. Excluding the impact of foreign currency, international sales increased 11% for the third quarter and the first nine months. On a local currency basis, most of the international divisions are having a very good year.

Europe grew 11% in the quarter and is up is up 13% year-to-date with strong performances in the U.K., Enaloc Scandinavia, Spain and Italy. Japan grew 7% in the quarter and 9% in the first nine months with the strongest performance in orthopedic implant. Pacific was up 10% for the quarter, and 9% for the first nine months with the strongest performances in Australia and China. Canada and Latin America were up 23% for the quarter and 11% for the first nine months with the strongest performance in Latin America.

Orthopedic implant sales were $506 million for the third quarter and $1,519,000,000 for the first nine months, representing increases of 20% and 23% respectively based on strong shipments of reconstructive products, trauma and spinal implants. Spreading the impact of Orthopedic Implants increased 16% in the quarter and 17% for the first nine months. MedSurg sales were $323 million for the third quarter and $940 million for the first nine months, representing increases of 17% in both periods.

That's based on higher shipments of power surgical instruments, endoscopic systems, hospital beds and stretchers, craniomaxillofacial implant. Excluding the impact of foreign currency, sales of MedSurg Equipment increased 15% in the quarter and 14% for the first nine months. Concerning prior-year restructuring and acquisition-related items, there were two restructuring and acquisition-related items in third quarter 2002. First was the restructuring charge in the amount of $21 million for employment-related costs to close the company's Rutherford, New Jersey manufacturing facility. The aggregate cost was 14 -- after-tax cost was $14.1 million or 7 cents per diluted share.

This closure was resulted in a move of production to both Ireland and our new Mawa, New Jersey is complete, and we're very pleased with the out come. The second item was a credit of $3.8 million to reverse certain Howmedica acquisition-related costs to reflect actual final payments required. The after-tax benefit of this credit was $2.6 million or a penny per diluted share. Concerning minimum basic knee and hip procedures structure which are very hot topics today in orthopedics, we continue to move forward in our programs surrounding the Scorpio total knee instrument patient to complement Dr. Peter's technique for less invasive total knee replacement.

The results from the multi-center study to evaluate the safety and reproducibility of this procedure looked good so far. We rolled initial instruments out to the field in the third quarter and are planning a heavier rollout in the fourth quarter. We're making regional training available for interested clinicians. In -- and basic hips, our focus has been on instrument design for use in single mini incision total hip art plastic procedures. We placed instruments for use in this procedure in the third quarter and will evaluate the demand for need as we go forward. Training is also readily available for that procedure. Our Accolade hip system is an excellent system for use in many because of its simple instrumentation system.

Our OP-1 shipments slowed in the quarter as we faced expected supply constraints which primarily affected the U.S. market. These constraints resulted from work we've been doing to increase our future productivity and from an operational challenge associated with a product released test in one facility. The release test challenge was not a product quality issue, and we're currently shipping a product again to all critical global markets where OP-1 is approved. We are increasing our manufacturing capacity but do anticipate the capacity constraints will keep sales in our market demand OP-1 during the next several quarters.

As we neared the end of patient enrollment in North American un instrumented posteriad lateral spine fusion trial, our analysis determined that we need to enroll a few additional patients to improve the statistical significance of the final submitted data. This is primarily due to the enrollment of fewer autograft patients than had been planned. As a result, we now expect total patient enrollment of approximately 330 as compared to 312 that was previously told to you. We now hope to complete enrollment in advance of our fourth quarter earnings release conference call. In Japan we completed enrollment in the study using OP-1. These patients will receive a one-year follow-up before applying for a pivotal study, and with that, I'm delighted now to turn the microphone over to Steve McMillan for his observations on the quarter. Steve?

Thanks, John. Good afternoon, everyone. We mentioned last time that my initial focus has been on our core or orthopedic implant businesses. Our goal here is to continue to strengthening our marketing and sales efforts while also boosting our focus on R&D. Simply put, continue to delivering strong current results while preparing for sustained future growth. Now, more on the results. For the fifth straight quarter, we were pleased to deliver 20% sales growth across our total orthopedic implant business, and also 20% in that business's largest product lines as we recorded 20% growth in hips, 20% in knees and 20% in trauma, while our spine business grew 18% versus last year.

To be fair, we were also clearly helped by currency, as the operational growth rates were roughly four points lower, which we'll provide as we go through the details. In a nutshell, as we've been moving through the year, we've seen strong results driven by an acceleration in growth in both hips and knees, but slightly slower growth rates in trauma and spine. We are particularly pleased by our U.S. hip business, which driven by solid adoption of our Trident ceramic on ceramic hip grew a strong 23% over last year and accelerated even further from last quarter's 21% growth rate and up significantly from 8% in Q1. Ceramic inserts now account for over 20% of our total insert sales. To further drive this growth, you may be aware that we launched a patient education campaign in late September featuring legendary golfer Jack Nicklaus. This is new for us, and we're clearly breaking ground with this campaign, which is designed to broaden consumer awareness of both the Stryker name and our ceramic on ceramic hip.

We are very proud that Jack was one of the initial patients to receive a Stryker ceramic hip as part of our clinical trials, and we're pleased with the impact it's had on his life. While it's way too early to read results, we believe this campaign will continue the initial momentum for our ceramic hip in the months and years ahead. Despite the obvious focus on hips in the quarter, we were also pleased with accelerating performance in knees. Globally, sales grew 20% or 17% operationally behind widespread geographic and product line strength. Specifically, the U.S. was up 19%, and international was up 22%, again helped by currency.

Outside the U.S., growth for knees was 12% operationally, a significant acceleration from the 4% in Q2. Also on the positive side, our bone cement business posted strong growth in the quarter, driven by Simplex P with Tobramycin, our bone cement antibiotic combination which was approved in second quarter. Our trauma business also posted solid 20% sales growth, or 14% on an operational basis. While we believe these results are still above market growth rates, this growth rate is below that of recent quarters, principally due to a softer sales in the U.S. And with the impact of the SDI acquisition now behind us, our spine business came back to earth with 18% growth or 16% on an operational basis. We're doing a solid job with the cervical and author a columbar lines, but we're below our expectations in the interbody cage area.

As I announced in late September, we're currently making some changes to our spine business to bring greater focus to the important high growth U.S. market. In addition to the strong implant performances, the quarter was also a story of breadth and depth as MedSurg continued its strong performance with sales up 17% or 15% operationally. This growth was driven by plus 20% growth rates in both our endoscopy and instruments businesses, both of which are supplying a number of products, which are being used in minimally invasive surgeries. And as John mentioned, our physiotherapy business also recorded 13% sales growth, rounding out a quarter where all three groups posted at least mid teens growth rates. As you know, we also announced several management changes during the last month. In Stryker spine, Mike Minelli has announced his intention to leave Stryker Corporation to pursue new career opportunities.

In his place, we've appointed Tim Ascano Vice President and General Manager of Stryker spine as of October 1st, 2003. Tim is a talented manager who's done extremely well in a number of roles during his 13-year Stryker career. Tim began his career as a salesperson and gained broad sales, marketing and operations management experience at Stryker endoscopy. Most recently, he has led the initial commercialization of OP-1 as VP and General Manager of Stryker Biotech since 2001. We believe his past experience working with our OP-1 spine study at Biotech and with minimally invasive surgical markets and endoscopy make him uniquely qualified to tackle this new role and lead our spine business to the next level. With Tim assuming his new spine role, we're fortunate to have Jamie Kemler, group president, Stryker Biotech, Spine and Trauma available to step in to Stryker Biotech as acting president.

Most of you are familiar with Jamie and know that he did a great job leading biotech leading to his promotion to his current role. We are confident that biotech will be led well during Jamie's interim tenure. We also announced a series of changes impacting our reconstructive business that will be effective January 1st, 2004. These changes were triggered by Ned Lipes' desire to step down from the day-to-day responsibility of running Stryker Howmedica Osteonics to pursue his personal plans and spend more time with his family. Ned will move into an Executive Vice President role that will allow him to draw on his experience and knowledge to continue to assist us by contributing to the maintenance of key surgeon relationships, enhancing our future business development efforts and advising a new product and technology development, reconstructive implants.

During the last 16 years, Ned has played a key role in Stryker becoming the world's leading orthopedic company. He was a catalyst in the acquisition in successful integration of Howmedica. We want to personally thank him for his contributions to the company's growth, and we look forward to future contributions in his new role. With the change in Ned's role, we decided on two other strategic changes to best position our reconstructive business for future success. We are expanding the responsibilities of group president Ron Lawson to include Stryker Howmedica Osteonics along with his current leadership of Stryker international.

With his long tenure in the orthopedic industry, Ron has developed deep knowledge and great relationships in the U.S. marketplace that will help us transition Ned's leadership in a seamless manner. In addition, his overall role with responsibility for both the U.S. and international reconstructive franchises should help us hone our worldwide focus on growing these businesses. We are also promoting Jeff Paulsen from Senior Vice President and Chief Operating Officer of Stryker Howmedica Osteonics to president of that division. Jeff has been with Stryker since 1996, and has grown rapidly in the roles and responsibilities entrusted to him.

He has played a key role in the Howmedica integration and the successful restructuring of our reconstructive manufacturing operations, including the important Rutherford transition. We think you'll be favorably impressed with the leadership Jeff will bring to this business. And now we'll turn it over to Dean Bergy, our Chief Financial Officer, for more details.

Thanks, Steve. I will hopefully add a little more detail to what's been provided all together so far. Starting with the foreign currency impact on our operations in the third quarter, as John mentioned, the impact on international sales was $22.9 million favorable impact or 9% increase in those foreign sales. That brings our year-to-date impact to $98.9 million. The Euro strengthened 15% in the quarter and the yen strengthened 3% against the dollar. If currency rates hold at the end of the third quarter levels, we expect to see a positive impact on sales of about $35 million in the fourth quarter of 2003. Turning to our price volume analysis for the quarter, I'll go through the line items. Price had a positive impact of 2% in the quarter.

Foreign currency had a 3% positive impact. Acquisitions with the advent of surgical dynamics impact going away in this quarter had just a 1% impact, and volume and mix reached its high water mark for the year with a 13% impact, up to our 19% sales growth in the quarter. For the year, we're now at 2% positive impact on price, 4% on foreign currency, 2% on acquisitions, 12% on mix and, of course, up 20% for the year. U.S. implant prices were up about 4% in the third quarter and are up 5% for the first nine months. Prices in Europe are up slightly. In Japan, prices were down slightly in the quarter, and they're down slightly for the year.

Now turning to our business segments, as Steve indicated, Orthopedic orthopedic implant sales increased 20% in the quarter, and they're up 23% for the first nine months on an as-reported basis, and our current -- constant currency basis, 16% and 17% respectively. Now I'll give you some further flavor on the individual product lines. For the quarter, for hips, domestic sales growth was 23%. International sales growth was 16% on a reported basis, and hip growth in total was up 20%. For knees, 19% domestic growth, 22% international growth, and 20% total growth asreported. For our trauma products, 13% domestic growth, 24% international reported growth, and 20% total growth. Spine products were up 16% domestically, 23% internationally and 18% as reported in total. And as reported for our total Orthopedic Implants, 20% across the lines for both domestic, international and in total.

On a constant currency basis for the quarter, of course the domestic lines remained the same, international lines, hips, 7% for total operational constant currency growth of 15% for hips, knees international up 12%, total up 17%. Trauma, international up 15%, trauma, up 14%. Spine, international up 15%, total up 16%, and international total Orthopedic Implants up 11, and of course up 16% in total.

Now some individual comments on those product categories starting with hips. Hip growth in the third quarter was very strong led by our Trident ceramic on ceramic hip system in the United States which was introduced at the end of the first quarter. On a unit basis, ceramic insert sales were north of 20% of our total insert sales in the quarter.

We continue to believe we have enough inventory and instrumentation in the field to meet demand. In other stems used in the higher end ceramic on ceramic procedures continue to lead the growth in hips driven by our the accolade TNZF, citation TNZF and secure fit HA. Revision stems continue to do well led by the P3 modular revision hip system. Sales of acetabular cuffs are solid driven by the Trident acetabular system for polyethylene and ceramics. As you recall, the Trident acetabular system utilizes the same cup and shell system parking mechanism with the polyethylene and ceramic liners.

In Europe, Trident and exciter are doing well and ABG2 is steady. In Japan, super secure fit, and ABC ceramic on ceramic hips are doing well. Our new sun tower HA coated TRIAD cup which was launched in the second quarter is starting to ramp up nicely. Japan has been experiencing a slight mix shift from hip to trauma products as a result of the manner in which certain hip fractures are now being treated.

Now turning to knees, we did have a great quarter in knees with both Scorpio and Duracon achieving strong growth in the United States. Duracon TS and Scorpio TS revision systems also did very well. Scorpio Flex knee for patients requiring an extended range of motion was launched in the U.S. last year and continued to make excellent progress in the market in the third quarter. The modular rotating knee hinge has also been well accepted in the U.S.

In Europe, our Scorpio knee had an excellent quarter, and Kinemax had a solid quarter in the U.K. Our postier yoe deep flexion knee products, Scorpio super Flex PS had a good quarter in Japan and our deep flexion knee product also had a great quarter in the Pacific. EIUS, our minimally invasive uniknee continues to be our fastest growing knee product.

Trauma also had a 20% growth quarter with stronger growth overseas where we have put more emphasis recently on dedicated sales organizations. The T2 intermedullary Larry nail system, which was launched in the U.S., Europe and Japan in 2001, continues to drive our trauma growth and set new sales records.

Our gamma hip fracture devices also had an excellent third quarter, particularly overseas. Sales of external fixation products were solid in the United States and very strong outside the U.S. Spine sales growth was led by sales of thoracolumbar products primarily our ZIA2 system which was launched late last year. ZIA2 offers an improved screws and instrumentation. The reflex anterior cervical plate also had a very strong quarter.

Sales of inter abdicates acquired applied surgical dynamics appear to be stable. Turning to our MedSurg group you talked about great results there just a reminder, that group is comprised of four operating divisions. Our instruments division which comprises about 41% of the sales there, endoscopy, about 31% of sales, medical about 19%, and Leibinger about 9%. As we indicated, MedSurg sales were up for the quarter and the first nine months, and 15% for the quarter and 14% for the first nine months on a constant currency basis.

Turning to our instruments line, that line was up 21% in the third quarter and 22% year-to-date as reported, and 18% for both the quarter and the first nine months on a constant currency basis. Looking at the individual product lines there, the powered instruments line was up 16% domestically, 20% in the international markets and 17% in total. Our other OR equipment was up 25% domestically, 29% internationally, and 26% in total, and in total, instruments was up 20% domestically, 24% internationally and 21% in total. Instruments had an excellent quarter based on steady growth in powered instrument systems and strong shipments of other OR equipment. Domestic growth was the best this year at 20% and growth outside the U.S., still up from prior quarters still topped the Stryker gold standard by a wide margin.

Our system 5heavy duty powered system had an an especially strong quarter and Michel powered to our strategic growth. Steri-Shield, the Neptune operating waste management system, pain management and percutaneous cement delivery also sold extremely well in the quarter, and deet compressor diskectomy probe acquired in the fourth quarter of 2002 continues to build momentum.

Now turning to endoscopy, they were up 27% in the third quarter and 21% for the first nine months as reported and 26% for the quarter and 19% for the first nine months on a constant currency basis. A great quarter for endoscopy, and I'll go through the product lines. Arthroscopy business was up 27% domestically, 51% internationally, 33% in total. General surgery was up 18% domestically, 44% internationally and 21% in total. Video was up 23% domestically, 65% internationally and 29% in total.

In total, endoscopy business was up 22% in the United States, 53% overseas and 27% in total. As I said, endoscopy had a great quarter based on outstanding growth in video and arthroscopy in general surgery. U.S. growth of 22% was excellent, and overseas growth, where we have lower market penetration and have been building our sales forces, was extremely strong. Our camera sales were very strong and there continues to be a lot of activity in the endo suite and communications area. showed solid growth and sports medicine products are starting to ramp up nicely.

Turning to Leibinger, as you heard, Leibinger sales increased 1% in the quarter and were up 5% for the first nine months. Domestically, the business was up 1% in the quarter, 2% internationally and 1% in total. Our CMSF businessofficial business had a solid quarter as did our Colorado electro carteri needle. Navigation here had a soft quarter, but we still believe this business has good potential to make a difference orthopedic procedures as we go forward.

Turning now to our medical business, they were up 6% in the third quarter and 11% for the first nine months as recorded and on a constant currency basis, 4% in the quarter and 9% for the first nine months. The domestic business as we said was up 9% in the quarter, international was down 4, and in total, up 6.

The medical division had a good quarter in the U.S., the stretcher business showed nice growth and our EMS line was boosted by the EMS Stair Pro, which was introduced in the first quarter. U.S. hospital bed sales slowed in the quarter, but the incoming order trends look good. And as you heard previously, physiotherapy grew 13%, bringing year-to-date revenue growth to double digits at 10%, and they've continued as John indicated to adapt to the clarification and Medicare quoting guidance that was effective July 1st, 2002. Startups and acquisitions have contributed most of their growth this year, same stores sales are up 2%, and Physio ended the quarter with 369 centers.

Turning now to the P&L in a little more detail, and have you that from our press release, but our overall margins in the quarter are up slightly from last year, 62.5% to 62.9% this year. On a sequential basis, the margins declined slightly from the second to the third quarter, primarily due to a somewhat higher mix of MedSurg sales in the quarter as orthopedic implant sales are impacted by a summer slowdown in elective surgeries scheduled in many markets. The transition out of our Rutherford manufacturing facility is complete, and it has gone smoothly. We expect to see the benefit of this transition beginning in the fourth quarter.

Turning to our R&D spending, it's up 27% year-to-date, and the R&D ratio as a percentage of sales has increased from 4.8% in the prior year to 5%, as we put increased focus on our development efforts. The SG&A ratio is also up compared to the prior year. As you know, we have grown our dedicated sales forces and been faced with higher insurance costs this year. In addition, these costs are up in the quarter due to higher amortization expenses associated with loner instruments and higher advertising and costs associated with the patient education campaign.

Operating income before non-recurring charges increased 16% in the third quarter and operating margins were down slightly from last year due to the increased R&D and SG&A spending. Our interest expense continues to decline nicely. I will give you the numbers on the accounts receivable securitization discount, which is included in SG&A expense. That number was 0.7 million in the third quarter, and it's $1.9 million now year-to-date, so total interest plus accounts receivable securitization was $6.5 million in the quarter, bringing the year-to-date total to 21.1 million.

That's down37% from last year's $33.6 million. Intangible amortization increased $1.5 million in the quarter and $8.8 million year-to-date with that year-to-date increase being primarily attributable to the surgical dynamics acquisition. Other income consists of three components and I will break those down for you. For the quarter, interest income was $200,000. We had a foreign currency transaction loss of $500,000 in the quarter, and minority interest was $100,000.

That adds up to the $400,000 loss experienced on that line. as you saw in our press release, the income tax rate for the first nine months was reduced to 30.5% bringing the effective tax rate for the third quarter to 29.5%. This compares to an income tax rate of 33% for the prior-year quarter and first nine months and an effective annual income tax rate of 31.8% for 2002. The rate reductions result primarily from increased manufacturing in lower tax jurisdictions such as Ireland and Puerto Rico.

Turning to the balance sheet, you can see that's in great shape. I will remind you that our accounts receivable securitization program was expanded during the second quarter from the previous $130 million maximum. The maximum is now $200 million, and we are currently at $195.6 million out on the accounts receivable securitization program. Accounts receivable securitization program. Accounts receivable based in the quarter finished at 64 days.

That is up two days from the prior year primarily as a result of increased sales overseas. Inventory days are down nicely in the quarter to 127 days. That compares to 142 days in the prior year and that is just one day above our record low set at the end of last year. Our total debt plus accounts receivable securitization declined $179 million in the quarter, and through nine months, it's down $264 million based on a strong operating cash flow that we have, and as John indicated, that brings our total debt in at $368 million. Cash flow from operations was very strong in the first nine months. It finished at $436.6 million. $371 million if you back out the proceeds from the accounts receivable securitization. This is up 16% from last year despite heavier tax payments in 2003. With that, I'll turn it back over to John.

Thank you, Dean, and thank you, Steve. What we'd like to do now is open up for questions. After we have the questions, we will have a short wrap-up. So we're open now for questions, Kelly.

Thank you. Ladies and gentlemen. [operator instructions] One moment, please, for the first question.

The first question is from the line of Bruce Jacobs with Deutsche Bank Alex Brown. Please go ahead.

Great. Good evening, guys. Just a question if I would on the ceramic on ceramic penetration. Can you just perhaps, I guess, talk about what kind of penetration you have into the total number of accounts that you have on the recons? I'm just trying to understand how well penetrated it is in terms of the number of accounts, and if at this point this has been used to gain any new accounts or if you're still really just converting your own.

Bruce, at this point, we're still doing a lot of converting of our own. To be frank. We think there's still significant upside with competitive users. We're starting to here more inquiries, frankly, but most of the initial gains have been from our own customers.

And Steve, can you give us some insight into the penetration that you mentioned? Is that representative of having penetrated half of your accounts with that product, two-thirds, a quarter? Just a rough idea?

You know what, Bruce, I honestly don't know the exact answer to that. I can tell you most of our reps have sold some into most of their surgeons. But the true penetration, we're still getting certain heavy user early adopters that are counting -- accounting for big chunks of the volume.

Ok. And I think it's usually about this time of year, if I'm not mistaken, that you establish your price increases for the coming year in recon. I'm won wondering if you have done that and would give us a sense of where your thoughts are on that matter.

Bruce, we do put in our price increases in recon usually at the start of September. We do like to kind of see what takes place over time, so I'll be better equipped to answer that question during our next call. I would tell you that we would still expect to see price increases, but I would not be surprised to see some erosion from the level of where they've been in the last couple years.

Ok. And just one last question, if I could, on the spine business. I know you have now normalized comparisons, but can you just comment on the overall market, whether or not from a procedure growth standpoint, you've seen any significant changes in the growth in either direction?

The procedure growth seems to be continuing strong, and frankly, particularly in the U.S., we don't think we've kept pace in the last quarter.

Ok. Fair enough. Thanks, guys, for your time. Congratulations.

Thanks, Bruce.

The next question is from the line of Jason with Morgan Stanley. Please go ahead.

Hello. Thank you. First off, on the SG&A spending, it was a little higher than we expected. Is that the Jack Nicklaus effect? In other words, is that spending for Jack Nicklaus that we saw in this quarter?

That sounds like a Dean question.

I mentioned four items, really. That certainly has a small impact, but, you know, the other items that I mentioned also have an impact.

Ok. Well, I guess the question would be, then, how should we -- for this going forward? Is your SG&A going to be a little higher from now going forward as part of this patient education effect, or am I just over blowing the actual expense involved?

It will be up a little bit, but it's not that significant, I don't think.

OK. And then on your ceramic hip mix, you said that your line of ceramics make up approximately 20% of your units this quarter. The question, I guess, is, how high can it go, and how high are you expecting to go at this point now that you've had two quarters of sales to look at?

We're not sure how high it can go yet. We continue to see what surgeons are reacting to, and we're north of 20. I think it will do well, but probably somewhere less than 100%.

OK.

It's still too early to tell.

And am I correct in assuming that that - when you say 20% liner sales, the stem is not necessarily ceramic stem that people are putting in, so people may be putting in ceramic cup with a metal stem, and ultimately -- well, let me take back that question. Ok. Thank you very much.

Great. Thanks, Jason.

The next question is from the line of Rick Weiss with Bear Stearns. Please go ahead.

Hello. Good afternoon.

Hi, Rick.

Couple questions. First knee performance was pretty extraordinary in the quarter. You talked about a couple of reasons. Can you expand a little more and maybe break it down U.S. - to what degree is a sales force, mix, help us appreciate what's going on and how sustainable it is.

Rick, really both in the U.S., we were really pleased, in both Scorpio and Duracon both had great growth. We would till you a little bit of it, we think, was refocusing and frankly we think we got some rub off on success of our ceramic on ceramic hip.

Are you actually bundling?

No, we're not bundling, but human nature, our sales force is feeling pretty good right now. They're having a lot of success with the ceramic hip and we think that's carrying over, getting some momentum.

Let me just add they are really are not a lot of new products here we are moving towards a new product next year. We think this is extremely positive given the fact that, you know, we did so well with our existing products this year.

But international was particularly impressive, particularly following -

Kelly, come in just a minute.

Yes.

We were told here that some transmission was being lost. Do you know, is that true or not?

I've heard everything that you have said as well as the participants.

Ok. Maybe it was the Web cast then. Ok. Thank you.

You're coming through loud and clear on this end anyway.

Thanks, Rick. Sorry to interrupt.

That was just the international portion, you know, can you, again, elaborate on the performance there, operational growth was pretty impressive.

You know, really probably two things, Rick. One is, we are putting more and more focus on our recon business. We see a lot of momentum in it, we've been driving that forward. The other piece to come back to Jason's question a little bit on SG&A, we have rededicated some of our selling organizations in a lot of the markets outside the U.S. where we've built separate MedSurg sales forces, and that's allowed some of our recon folks to -- or some of our salespeople to refocus on the recon business, and we think we particularly started to see some of the effects of that in Europe in the third quarter.

Ok. Couple other smaller quick ones. The OP-1 capacity constraints, can you remind us what's needed to resolve that, and how long it takes?

There's really two issues. The capacity constraints themselves, we are investing significantly to expand our plant facilities in that business, and that's going to takes years. Frankly, we've got to build the facility, run the qualifying runs, submit them to FDA, and get it there. In the meantime, what we're trying to do is get some additional throughput through the facility, and what we really had in the short term was a short-term hiccup on one of the assays, and we've got that fixed.

And last, you mentioned that you're out of Rutherford and the potential positive incremental benefit to gross margins in the fourth quarter. Can you quantify that in any way for us?

Well, you know, I have to say, the fourth quarter is generally a quarter where we get some margin pickup, and it's probably a little early to tell. I think it will probably be, you know, at least a half a point of margin.

And so sustainable going forward?

Yes, we certainly would expect to. That's the reason we made the move.

Exactly. Thanks so much.

Thanks, Rick.

The next question is from the line of Wade King with Wells Fargo Securities. Please go ahead.

Hello. Good afternoon, gentlemen. Very nice quarter. Couple of clarifications. First, if I may, and then one question. The comments you made on pricing earlier, I don't want to raise serious questions going forward about pricing power in the marketplace, but does your comment reflect push bang pushback from hospitals at this juncture, does it reflect the fact that, you know, you've advanced certain price increases as of September 1 and you're still evaluating how easy they're being accepted? Could you just clarify the comment, please?

We clearly are waiting to see how they're being accepted, and, you know, I mean, my erosion comment, I think, is also forward-looking to some degree into the future. I mean, we've been obviously in a healthy market. You know, we certainly expect that we will have price increases going into next year. I just don't know that they'll be 5% but, you know, it's likely they will certainly be, you know, in the 3% to 5% range probably.

So you meant erosion from the rate of price growth in past years?

That is correct. When I said "erosion," I meant erosion in the rate of increase, not erosion in terms of prices going down.

All right. Thank you. And Dean, for the year then, would we expect the tax rate to be 30.5%?

You know, certainly having made the change we did, and we evaluate our tax rate looking out through the year, we're certainly comfortable with the rate at this point in time. Now, you know, there are other events that could arise, and I will tell you that certainly as we go forward, looking into future years, we still would see given the moves we made downward bias in that rate.

Thank you. And the comments per OP-1, as I recall, you're limited in your approval by the HDE to 4,000 patients in terms of use of the product, so given a capacity constraint issues that you addressed, can you give us some kind of idea that even with the 4,000 patient constraint by the HDE, you're tracking below expectation, can you give us an idea of how many patients the products have been used in in recent quarters, for example?

No, I don't think we could give you that information, Wade. I'm sorry.

Ok. Last part then, the question, per your spinal performance, given there's another obviously BMP product in the market with spinal application, do you think your reference to constraint on the U.S. side possibly not keeping up is related to infusion? Is there a battling issue, for example, Medtronics cages or their hardware on the spinal side do you think or some thing else is going on?

Good question. They're doing very well with the bundling of the cages in end use. Frankly, we acquired the cage business about a year ago from SDI. We've been learning how to sell them and bought them down a little bit and they seem to be coming back now.

All right. Very good. Thank you very much. Congratulations on the quarter.

Thanks, Wade.

The next question is from the line of Bill with First Albany.

Thank you. Good evening, gentlemen.

Hello, Bill.

Hello. Just real quick on the -- a little more on the spine procedures. Could you give us an idea what the underlying procedure growth rate in the U.S. is in your opinion, and then secondly, flip over to the tax rate, you mentioned 30.5%. Is that for full year 2003, and then should we use that same assumption in 2004?

On the number of procedures, I don't think we know. We'll -- but Dean will give you a ood clear answer on tax rate.

It wasn't number of procedures, it was the actual procedural growth rate in spine. So is the underlying unit growth, you know, 10-, 11-, 12%? Do you think?

That's probably not -- that's probably in the range, I would guess.

Yes, I don't think we have the exact number for you here, Bill.

Bill with First Albany ed: Ok.

That would sound reasonable. Sorry.

Bill, on the tax rate, you know, as I said before, I think, you know, we're certainly comfortable with 30.5% for this year. I would expect it to come down, and probably the next step down would be to 30. I can't tell you for sure that we're forecasting that for 2004, but certainly as we look out, it's certainly plausible and certainly we would expect to get there sometime next year or two.

Ok. Great. And then one last question on the hip -- ceramic hip product. Are there any supply issues with that? I know you said you had enough inventory of both ceramic and instrument, but, you know, has your supplier been able to keep up with -- and supply you with everything you're looking for?

Yes, we had no problems in the quarter. We were a little slow out of the gate as we ramped up, but we're fine now.

Ok. And then lastly, you had mentioned some new knee products coming out next year in the U.S., could you give us a little color on that? And that's my last question. Thank you.

Well, at this point in time, we have a meeting coming up at the AAOS, and I think we'll give more color on that at that point in time.

Great. Thanks a lot, gentlemen.

Thanks, Bill.

The next question is from the line of Katherine Martinelli with Merrill Lynch please go ahead.

Oh, great. Thank you. Just a couple questions and one maybe just more kind of strategic in terms of just looking at the business when you think about the leverage you're going to get from shutting the Rutherford facility and the lower tax rate and very strong top line growth you're seeing. What should we be thinking about for the business in terms of the next year or so? Is there potential that the earnings growth rate for some short-term period continues to be above the 20% target, recognizing it wouldn't be your long-term goal but it does seem that it's going to be difficult to maintain the earnings in that 20% goal next year, particularly with currency looking like it's going to continue to be favorable?

Katherine, we're looking for more upside in the fourth quarter, and I'll comment on that, due to ramp-up, but as far as our goal for 2004, expectations are now that that will be up 20% from the reported number in 2003.

Ok. Thank you. And then just a couple specifics. You mentioned very strong gamma hip fracture growth outside the U.S. Is that tied to the comments you made about a change in how procedures are treated in Japan, or am I misunderstanding what that said?

No, I think that's fair, Katherine. I think we also are putting some sales focus in that part of the market as Steve mentioned, with-- but I think that is a fair comment.

Ok. And then just a couple specifics. Could you give us a sense for what your extremity growth was in the quarter and what your bone cement growth was?

We don't give out those numbers specifically. You know, bone growth was very strong. We're clearly benefiting from the introduction of Simplex P with and our numbers are significantly above the markets at this point in time as we are getting the pop from that coming out. Upper extremities, I don't know if say mid to high single digits.

Ok. That's very helpful. Thank you.

Thanks, Katherine.

The next question is from the line of Rob Faulkner with Prudential Securities.

Thank you. Again, very impressive. Two items. One, I wonder if you could look forward on the issue of mix, and industry wide and for you, you obviously enjoy more than most. Much of the mix benefit in the industry seems to have been going from cement to cementless. I wonder how much further you think they can go, where it is now. And the second item is I'm wondering if you're seeing any changes in hospital purchasing or spending that would be relevant to medical business. As times get tougher for hospitals.

Clearly the growth has been in cementless. I think off the cuff growth in cementless was up like 30%. While cemented was down slightly in the quarter. It's up around 60% now. There's probably some additional growth to be had going forward, given the underlying growth rates. In terms of pushback from hospitals, certainly we see some of that on the capital equipment side in everything but we're continuing to do pretty well there and haven't really seen it affecting the business, but it is clearly the pushback and the constraints.

Do you have a guess estimate as to how high cementless can go as a proportion of your sales?

The Trends would indicate we're picking up, what, a couple points every year?

I think that's about right.

Yeah.

Ok. Great. Thanks.

Thanks, Rob.

The next question is from the line of Bob Hopkins with Lehman Brothers. Please go ahead.

Bob Hopkins Hi. Thanks very much, and again, my congratulations on a strong quarter. Just two quick questions here. First on spine, I'm wondering, do you guys feel that you have the distribution in place right now to be truly competitive with the Medtronics and J and J's of the world or is that something that you need to add to?

It's something we need to strengthen. We've gone through a little bit of digestion with the SDI acquisition both at the agent level and some of the distributors, and we need to realign and that's part of what we're doing right now.

Can you just let us know, what's the number of salespeople you have and is there a target have you in mind?

In spine specifically, Bob?

Yes, sure.

We have about 150 people right now, and I think Steve said we're still digesting that, so, you know, I think the issue right now is sales force productivity, not adding more, but certainly as we bring it together, we'll evaluate all of that.

OK and then -- thank you. And Dean, just one clarification. You mentioned something on the call about a reclassification between hip and trauma in Japan, I believe. Is that a meaningful reclassification? Does it impact the results?

It's not really a reclassification. It really is just products that are being used to do the procedures. Now they're using products that we classify as trauma hip fracture devices instead of what had been hip products. It's not that significant, but it did impact our hip growth a little bit in Japan. That's the reason I mentioned it.

OK. So any idea -- I mean, is that a full percentage point? Has it been closer to 16 or 17% without that?

No, no, not that much on the total business.

OK That's all I had. Thanks so much.

The next question is from the line of Ben Andrew with William Blair & Company. Please go ahead.

Good afternoon. Just a couple quick questions. John, you mentioned as your procedure growth and mix for the quarter was, I think, 13% and 12% for the year. Can you give us your perspective sort of going forward where that would be? You talked a little bit about price, but do you see that holding steady, or maybe even accelerating from here?

I don't think so.

You know, Ben, I think it's pretty strong. I mean, obviously we feel good about it, and it's been in that range, it's been in the 11 to 12% range. I think it topped out at 13% in the third quarter of last year as well. So, you know, it's certainly very healthy. To say it would accelerate would probably be, you know, pretty optimistic, so I think we feel good about it, but I think we feel good that it will at least probably stay that way for a while.

OK. And you said obviously your cage business is stable, I guess, in the quarter, presumably meaning it's roughly stagnant where it's been, and you mentioned the sales force productivity issue. Are there other things on the product side that you have in the near term that can start to move that needle or is it really going to be more structural things within that segment?

We will have some products come out. We've got some things in cervical that are -- they're going to be coming out and you'll see some of those if you go to the NAS meeting coming up here later this month, but, you know, really the cage area is the area where, you know, the business is stable and we really want to pick it up there.

Ok. Great. Thanks.

The next question is from the line of Joanne Winch.

Thank you very much, and very good quarter. Two quick questions. The first has to do with new hires. You said you weren't looking to hire in your spine position, but are there areas that you are looking to hire in? And then the second question has to do with OP-1. If you are manufacturing constrained and it will take several years to resolve that, how does that sort of play into the whole R&D OP-1 project?

Let me take the first question. On hiring, you know, it's pretty traditional, Joanne, that we go into the new year and beef up our sales forces, so I would tell you that, you know, across the board, we'll probably be hiring for sales forces throughout the end of this year as we go into the start of next year. I think in spine, you know, that's certainly an area where our sales force has been less productive and I think we've just got to come to grips with where we're at before we boost that number significantly. But, you know, trauma is an area where we want to put more focus particularly in the U.S., and certainly that will be an area of average heavy hiring for the sales force.

John Brown

And the second question? Joanne, on OP-1, why don't I take a stab at that. The key constraint for the next few years, to be clear, is not manufacturing capacity. It's our indication and our approval. So by the time we receive a full-blown approval for broader indications in spine, and we will have the capacity in place. But the next few years continue to expect OP-1 sales to be very small because of our very limited HDE indications.

Ok. Thank you very much.

Thanks, Joanne.

The next question is from the line of Mike Weinstein with J.P. Morgan. Please go ahead.

Hello,. This is actually Raj sten boy for Mike. Just a quick question, You said most of your ceramic on ceramic sales had been coming from existing customers, and especially in light of the fact that -- I don't know if you heard earlier in the week, J & J reported a pretty week constant currency hip growth, I think it was 6.5%. It seems surprising that you wouldn't be expanding into new customers, I thought your sales force would constrain themselves to not calling on surgeons they haven't called on before or even responding to calls they're getting on the device. So I'm curious for your comments on how that's really playing out.

We are making some progress competitively, we just don't want to overestimate it at this point and get carried away. Because what we've got is a number of surgeons trying it out early but, you know, whether they become loyal users is totally a separate question. So we don't want to declare victory too soon.

Ok. Thank you very much.

Thank you.

The next question is from the line of Scott Davidson with U.S. Bancorp Piper Jaffray. Please go ahead.

Hello, good afternoon and nice quarter.

Thank you, Scott.

John, can you maybe address the issue of management succession in a little bit more detail? There have obviously been some changes recently, some changes that were made longer ago that have had some time to play out. What should we be looking for over the course of maybe the next six to 12 months in terms of maybe the senior management team?

I don't think you're going to see any other significant changes. Really what triggered this was Ned came to us earlier in the -- well, I guess a couple months ago and said, look, I don't want to keep doing this, I love it but I want to slow down a little bit, so that triggered then taking a pretty hard look at the way we were organized and wanting to put worldwide emphasis on the recon business, and so Steve then came up with the idea, why don't we put all of that under one individual, so that's how we came up with the idea of putting Ron Lawson in charge of that, and then we had to have somebody to run Howmedica Osteonics, so Jeff, then, was promoted to replace, in effect, Ned, so that's really what happened there.

The situation in the spine area is that Mike decided that he was going to do something else. He's done -- Mike has made tremendous contribution to this company in the last five or six years. He turned Japan around for us, he put us on the map in the spine business, he led the charge to acquire SDI, and we're really grateful for what he has done, but he's decided to do something else.

So that triggered a need for another change, and we weren't particularly anxious to make a change with Biotech, but when they counted noses, I think Steve and his advisors all came to the conclusion that Tim would be the guy to get that business really going in particular here in the U.S., so that's what triggered all that. Now, from that, I realize from the outset, they're saying, well, they brought in Steve McMillan, a new president and they're going through a bunch of changes, therefore, there's going to be a lot more. That's the wrong conclusion.

We have brought in Steve McMillan. He's doing a fantastic job for us. But the changes that are occurring here really were not triggered by Steve joining this company. They were issues of individuals where they decided to do something else, really two people that triggered all the changes. I would tell you that going forward, I don't anticipate any major changes in the executive group in the next six to nine months, and I don't think -- Steve is shaking his head, he doesn't either.

Great. Thanks for clarifying that. And then relative to the ceramic on ceramic, the speed of conversion, it seems like it's been pretty remarkable, and if our numbers are right, that's been more rapid than it was for metal on metal. Does that speed of conversion, do you think, read either on how metal on metal will play out against ceramic on ceramic, or just sort of, you know, who wins in the end?

You know, it's a little too early to full fully have the read on that at this point. We're doing all we can, we believe very strongly that we've got the best product on the market, but the full adoption rate really -- it's still early and still needs time to play out.

Just lastly, can you just remind us roughly of the dollar magnitude for ceramic on ceramic liner of the revenue premium versus a crossfire liner?

It's around 15%, I think, total implant.

Thanks very much.

Thanks, Scott.

The next question is from the line of Michael Lockman with Think Equity Partners.

Thank you. If you could elaborate a little bit more on your efforts in minimally invasive hip and knee surgery. You mentioned briefly that you were up and running in training. Can you quantify at all sort of the rate at which you're training surgeons for some of these techniques, and can you comment also on some of the competitive dynamics resulting from minimally invasive? Are you seeing the training of surgeons and the introduction of new techniques and products as a driver of share shifting for either you folks or other companies within orthopedics at this point?

Michael, you know, our own experience so far in terms of training people has been very, very minimal. We're really getting into it. This is an area that we want to be careful in and make sure that, you know, we know what we're doing. You know, we're playing with patients' lives here, and just an area that we're going cautiously. Obviously responding to the trends, but making sure that we really know what we're doing.

Great. And given the fact that there's at least one other competitor that's taking a more aggressive approach, what are you seeing in terms of competitive dynamics and is that turning out to be a threat to your core market share, you know, any of your core customer relationships within Orthopedic Implants?

No, it's creating a lot of buzz in the marketplace, to be honest. You guys pick it up, we all pick it up talking to the surgeons and the surgeon community. There is some real buzz out there. In terms of meaningful share penetration, we don't see it moving dramatically. You know, some surgeons moving over, yes. Is there a mass wave of people moving? Now, you know, at the end of the day, we think a lot of the surgeons are looking at, frankly, MIS as a generic procedure that they will move to, and we believe in the long run, it's going to be who has the best implants wins.

Great. Thank you.

There are no further questions at this time. Please continue.

You have no further questions? Kelly?

There are no more in the queue. Would you like me to ask again?

No, that's fine. We've probably overstayed our welcome.

Just to wrap up here, we had an excellent first nine months, and we continue to be very optimistic about the markets that we're participating in, and the underlying procedural growth rates. As we enter the fourth quarter, we're well positioned to reach our goal of 3.6 billion in sales, and we believe that this would send a strong signal to the investment community and to the clinical community that we continue to have our resolve to be the number one orthopedic company in the world. We're not about to give that up as we go forward.

We think that we'll do about $3.6 billion for the year. That's pretty much on track for our five in five goal for the year of 2005. Based on our strong performance to date and our projections for the remainder of the year, we're increasing our net earning scope of 2003. From 2018 cents to 223 cents. And here we would just caution you that goal is really 223, and we've done enough work now to conclude that that's about what we're going to come in with. I don't think there's any upside potential from the 223 here.

This will be a 27-cent increase on net earnings before the restructuring and acquisition-related non-recurring items. And in answer, I think it was to Katherine Martinelli's question, our goal for 2004 is to have 20% earnings growth over 2003. You can do the math, but it's 20% on top of 223 that would bring us to 268. So two numbers to keep in matter 223 for the year 2003, and 268 for 2004.

Fourth quarter earnings would pop up from 52 cents to 66 cents to match all the arithmetic we've given you before. And if you want to write this down, we'll schedule our conference call for year-end fourth quarter operating results will be at 5:00 p.m. Eastern Time on Thursday, January 29th. 5:00 p.m., Thursday, January 29th, and we're planning on hosting an annual -- our annual analysts' meeting during the AAOS in San Francisco, and that will be at 8:00 a.m. on Thursday, March 11th, 2004 for the analyst meeting.

And again, we are grateful for everybody dialed in and listened, and appreciate your questions. Hope you're having a good quarter, and we'll look forward to seeing a few of you at the meeting in a couple weeks and seeing many of you then at the academy in March and talking to all of you again on the January the 29th. With that, we wish you a good evening. Thank you.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.